Working Papers 131-140

131. A Theory of Path Dependence in Corporate Governance and Ownership (Bebchuk, Lucian Arye and Mark J. Roe) Published in Stanford Law Review, Vol. 52, pp. 127-170, October 1999

Corporate structures differ among the advanced economies of the world. We contribute to an understanding of these differences by developing a theory of the path dependence of corporate structure. The corporate structures that an economy has at any point in time depend in part on those that it had at earlier times. Two sources of path dependence—structure driven and rule driven—are identified and analyzed. First, the corporate structures of an economy depend on the structures with which the economy started. Initial ownership structures have such an effect because they affect the identity of the structure that would be efficient for any given company and because they can give some parties both incentives and power to impede changes in them. Second, corporate rules, which affect ownership structures, will themselves depend on the corporate structures with which the economy started. Initial ownership structures can affect both the identity of the rules that would be efficient and the interest group politics that can determine which rules would actually be chosen. Our theory of path dependence sheds light on why the advanced economies, despite pressures to converge, vary in their ownership structures. It also provides a basis for why some important differences might persist. Working Paper No.131.pdf

132. Corporate Governance and the Voice of the Paparazzi (Lowenstein, Louis) February 1999

T his is one of a group of papers, at Brookings awaiting publication, celebrating the remarkably sustained value of Albert Hirschman's "Exit, Voice & Loyalty," published in 1971. Those who know that book -- and everyone should -- recognize that exit-voice has particular relevance in corporate governance. It is a conundrum: shareholders "exit" at a turnstile pace -- turnovers of 75% a year in NYSE stocks -- and shareholder "voice" only from a handful of state/local pension funds. Why then has the American corporation come to be seen as the paradigm? The paper focuses on the exceptionally high degree of financial transparency here, far better than elsewhere, which with the high degree of public confidence and interest engendered thereby have produced an extraordinary level of media attention -- the voice of the analysts and other paparazzi -- helping greatly to explain the palace upheavals at GM, Kodak, Westinghouse and elsewhere. Far from being an isolated phenomenon, it is simply one aspect of a society and market structure that could function well only with pervasive sunshine. The paper looks also at Germany, Japan, and (ach!) So. Korea and the like. Working Paper No.132.pdf

133. Employee Stock Ownership in Economic Transitions: The Case of United Airlines (133 Employee Stock Ownership in Economic Transitions: The Case of United Airlines 133 Employee Stock Ownership in Economic Transitions: The Case of United Airlines (Gordon, Jeffrey N.) Published in Bank of America Journal of Applied Corporate Finance, 1998

Employee stock ownership is usually discussed in terms of its normative desirability as a model of workplace relations or its general (in)efficiency properties. This paper considers employee stock ownership transactions as an adjustment mechanism for economic change. The starting point is the "employee stock ownership" is not a self-defining form and that specific institutions of economic participation and governance participation very much affect the viability of any particular transaction. The paper then considers the various rationales for employee stock ownership in situations of economic transition, rejecting claims of "just allocation" but suggesting that such transactions can overcome bargaining pathologies and thereby conserve the value of the firm. One important question is whether employee stock ownership transactions produce a transitional organizational form that quickly reverts to the standard firm or an organizational form that manages economic transitions in a superior way.

These issues are explored in the recent employee acquisition of a majority ownership of United Air Lines. The transaction provided for long-term employee ownership, not simply a transitional form, and so locked up the employee stock in an employee pension plan and provided employees with longterm governance rights. The evidence to date suggests that employee ownership has enhanced UAL's competitive position but that governance pressure from employees when their interests are directly at stake is a potentially destabilizing force. Working Paper No.133.pdf

A series of important corporate governance questions are likely to be addressed by the Delaware Supreme Court in the near future: whether a board can in fact "just say no" to a hostile bid; whether a board can thwart a proxy fight to redeem a poison pill through a "continuing director" provision in its pill (what might be called "just say never"); and whether shareholders can use their power to amend bylaws to constrain the adoption and maintenance of a pill. It is important that these questions be resolved in a way that maintains a vibrant, if not unconstrained, corporate control market. This is because control markets potentiate the use of capital market signals in the monitoring of managerial performance, which is especially important in an especially competitive domestic and global economic environment. Despite increasing institutional investor activism, the realistic possibility of a hostile acquisition is a necessary ingredient to an optimal corporate governance regime for large public corporations in a stock-market centered capital markets system.

The article argues in doctrinal terms that "just say no" is not the rule in Delaware and that, at a minimum, in the case of a firm with a staggered board the retention of a poison pill beyond the insurgent's initial electoral success is no longer reasonable. Similarly, pills with continuing director provisions (so-called "deadhand pills") violate Delaware statutes that govern the constitution of the board and director authority as well as fiduciary norms that protect the shareholder franchise. Finally, since statutory formalism does not resolve the question of shareholder bylaw amendment authority, the Delaware court should adopt a model of shareholder choice that in, reserving residual governance authority for shareholders, would permit such a bylaw that generally limited the use of poison pills. Working Paper No.134.pdf

135. The Shaping Force of Corporate Law in the New Economic Order (Gordon, Jeffrey N.) Published in University of Richmond Law Review, Vol. 31., No. 5, pp. 1473-, 1997

This article, based on an invited lecture, argues that the current corporate governance regime plays an insufficiently appreciated role as a shaping force in the current U.S. economic framework. The dominant corporate law norms and the particular distribution of shareownership have combined to produce a responsiveness to capital market signals that has made U.S. firms especially strong worldwide competitors. This responsiveness, and the associated economic success, is at risk because of continuing state legislative and judicial changes that increase management's ability to resist a hostile takeover bid. Institutional investor ownership and activism is insufficient; legal rules matter because they set the framework within which institutions (and catalytic forces like control entrepreneurs) can act. The paper traces the emergence of this corporate governance regime in the 1980s and 1990s, explains its importance to the emerging economic order, and focuses specifically on the Virginia antitakeover statutes and cases as a particularly troubling development. Working Paper No.135.pdf

136. An Economic Analysis of the Guarantee Contract (Katz, Avery W.) Draft version: March 1998, Published in the University of Chicago Law Review, Vol. 66, No. 1, pp. 47-16, 1999

Guaranty arrangements, in which one person stands as surety for a second person's obligation to a third, are ubiquitous in commercial transactions and in commercial law. In recent years, however, scholarly attention to the topic has been scant; and there is still no theoretical treatment of this body of law or practice from a economic policy perspective. This paper, accordingly, attempts to outline the basic economic logic underlying the guaranty relationship, and applies the results to a variety of specific issues in government policy and private planning. It poses and answers three main questions: First, why would a creditor prefer to make a guaranteed loan rather than an unguaranteed one? The answer is not as obvious as might first appear, given that market competition over credit terms tends to adjust the interest rate paid by an individual borrower to reflect the specific default risk that he presents. Second, given that they bear the residual risk of debtor default, why would guarantors prefer to guarantee loans rather than make loans directly, thus foregoing the opportunity to earn interest payments that could help to compensate for the risk they bear? Third, even if it is efficient for one creditor to provide funds and another to provide insurance against default, why would the parties prefer to implement this arrangement through the triangular form of a guaranty, instead of simply having the former creditor lend to the latter and the latter lend to the ultimate borrower? Working Paper No.136.pdf

We survey the evidence on the relationship between board composition and firm performance. Boards of directors of American public companies that have a majority of independent directors behave differently, in a number of ways, than boards without such a majority. Some of these differences appear to increase firm value; others may decrease firm value. Overall, within the range of board compositions present today in large public companies, there is no convincing evidence that greater board independence correlates with greater firm profitability or faster growth. In particular, there is no empirical support for current proposals that firms should have "supermajority-independent boards" with only one or two inside directors. To the contrary, there is some evidence that firms with supermajority-independent boards are less profitable than other firms. This suggests that it may be useful for firms to have a moderate number of inside directors (say three to five on an average-sized eleven member board). We offer some possible explanations for these results, based on board dynamics, the informational advantages possessed by inside (and, often, affiliated) directors, and the value of interaction between different types of directors who bring different strengths to the board. Working Paper No.137.pdf

138. General Principles of Company Law for Transition Economies (Black, Bernard S. et. al.) Prepared under the auspices of the Organisation for Economic Co-operation and Development - Gainan Avilov Institute for Legislation and Comparative Law, Russian Federation - Bernard Black Columbia Law School, United States - Dominique Carreau University of Paris, France - Oksana Kozyr Research Center for Private Law, Russian Federation - Stilpon Nestor Organisation for Economic Co-operation and Development - Sarah Reynolds Davis Center for Russian Studies, Harvard University, United States, Edited by Stilpon Nestor, Frederic Wehrle, and Sebastian Molineus Organisation for Economic Co-operation and Development, December 1996

In the context of the programme of the OECD's Centre for Co-operation with Non Member Economies (CCNM), a group of experts on company law was constituted to discuss and formulate a set of general principles of company law that can be of use to policy makers in the NIS as well as in other transition economies. These principles, presented in this publication, have four main aims: (1) to identify 'best practices' or main alternative approaches towards a modern company law, adapted to the special needs of transition countries; (2) to articulate these principles in a fashion that allows them to be used as a basis for on-going and future legislative reform; (3) to assist the drafters of model/comparative legislation in the transition context; and (4) help regulators and especially judges in interpreting and implementing existing and future legislation.

The CCNM is the focal point for the OECD's co-operation with transition economies in the Central and Eastern European Countries (CEECs) and the New Independent States (NIS) of the former Soviet Union. Its major responsibility is to design and manage a programme of policy dialogue which can take numerous forms, including conferences, seminars, expert meetings, and country specific advice in which policy questions can be explored and draft legislation reviewed. As part of its ongoing programme of assistance, the OECD, in co-operation with the Turkish International Co-operation Agency (TICA) and the German government, has created the Centre for Private Sector Development in Istanbul. This publication and related meetings were realised in the context of this Centre.

In September 1996 a small team of experts was constituted to draft the principles. The group included: Dr. Gainan Avilov, Senior Research Associate, The Russian Federation Government Institute for Legislative and Comparative Law; Professor Bernard Black, Columbia University School of Law, U.S.A. (general rapporteur); Professor Dominique Carreau, University of Paris I; Dr. Oksana M. Kozyr, Deputy Head of Department, the Research Centre for Private Law by the President of the Russian Federation; Mr. Stilpon Nestor, Head of the Privatisation and Enterprise Reform Unit (PERU) at the OECD; and Dr. Sarah Reynolds, Fellow, Davis Centre for Russian Studies, Harvard University, USA. The draft set of principles elaborated by the drafting team was submitted for discussion to a high-level experts group which met in Istanbul on 9-11 December 1996. Participants included senior representatives and company law experts from CIS countries and OECD member countries (see List of Participants).

Conclusions drawn at this meeting, following the presentation of the draft text and its extensive discussion by the experts, form the basis for the general principles published herein. These were finalised and edited in English by an OECD Secretariat team, which included Stilpon Nestor, Frederic Wehrle . In view of the aim of the general principles, it was decided to publish them simultaneously in Russian. Gainan Avilov and Oksana Kozyr supervised the editing of the Russian version. These principles are published under the responsibility of the Secretary-General. Jean-Pierre Tuveri, Director for Co-ordination, CCNM Working Paper No.138.pdf

139. Information Asymmetry, The Internet, and Securities Offerings (Black, Bernard S.) Published as part of a symposium on The Internet and Small Business Capital Formation Journal of Small and Emerging Business Law, pp. 91-99 ,1998

In this comment, prepared for a symposium on capital formation for small businesses, I express doubts about whether the Internet, as a new communication medium, will significantly reduce the cost of obtaining capital through a public or quasi-public offering. The most important single barrier standing between small companies and capital providers is information asymmetry potential investors do not know, and cannot easily verify, the quality of the information that a company provides. The internet cannot do much to reduce information asymmetry costs, nor the costs of the reputational intermediaries that emerge in securities markets. On the contrary, the Internet could increase information asymmetry costs by undercutting the effectiveness of the institutions that today provide investors with partial assurance of the quality of the information provided by issuers. Working Paper No.139.pdf

140. Deutsche Telekom, German Corporate Governance, and the Transition: Costs of Capitalism (140 Deutsche Telekom, German Corporate Governance, and the Transition: Costs of Capitalism) Columbia Business Law Review 185, 1998